Tuesday, August 30, 2011

CB - UN/Japan - Treatment of Gold in Balance of Payments Statistics

Treatment of Gold in Balance of Payments Statistics
Bank of Japan, January 2005,

"In order to understand the characteristics of transactions in gold and to find out proper treatment in balance of payments statistics, the Bank of Japan conducted a study on activities of cross-border transactions in gold performed by Japanese residents. Following are the main findings of the study:

(1) The magnitude of transactions in gold traded without any cross-border physical shipment is much larger than that of international gold shipments with Japan’s trading partners (see table 1 below). Transactions in gold without cross-border physical shipment involve gold that is deposited in metal accounts with a financial corporation in London; transfer of ownership is conducted by the settlement in those accounts.

(2) Japanese trading firms rather than financial corporations handle most transactions in gold that don’t involve physical shipment. Three major trading firms concentrate more than 90 percent of transactions of gold without physical shipment (see table 2 below). Historical reasons explain that these trading firms have played an important role in transactions in gold in Japan. After the World War II, the Japanese government banned exports/imports of gold so that national saving could be used to develop emerging industries. After the deregulation of gold transactions in the 1980’s, non-bank traders started dealing with international gold traders. Meanwhile, in 1982, banks were allowed to sell gold in retail markets, but were not allowed to get into wholesale gold markets. This measure was aimed to protect small non-bank gold traders. Large trading firms took advantage of this fragmentation of the gold market and expanded their transactions in gold into wholesale markets using their large capital funds.

(3) Most transactions of trading firms are forwards on gold. They are taking advantage of arbitrage opportunities on the OTC forward market in London, and on those between the OTC forward market in London and the future market in Tokyo Commodity Exchange. It follows that positions on forwards on gold are supposed to be offset at the time of the delivery date; however, the transfer of ownership of gold in metal accounts does not usually occur unless there are exceptional circumstances.

(4) Wholesalers of gold that import gold for industrial purposes do not engage in forwards in gold. They usually import gold using consignment contracts with Swiss banks and sell it to manufacturing firms in Japan when they deem it necessary. Since there are different ends to the use of gold and gold is fungible merchandise, gold wholesalers do not distinguish gold held for its storage value and gold held for other purposes, e.g., used in the industry..."

...

4. Distinction between Gold and Other Precious Metals
One may argue that forwards on other precious metals, such as platinum and silver, as well as other commodities can be traded the same way as forwards on gold in balance of payments statistics and international investment positions. How could forwards on gold be treated differently from forwards on other precious metals and commodities?The International Reserves and Foreign Currency Liquidity Guidelines for a Data Template states that forwards on gold should be included in the item of other reserve assets. Based on the Guidelines, it seems appropriate to include only forwards and options on gold that the monetary authorities used for the management of reserve assets.

We have the following arguments in favor of making a clear case between forwards on gold and forwards on other commodities.

First, forwards on other precious metals and commodities are not necessarily offsetable due to the lack of market liquidity. Therefore, such forwards fall outside the boundary of financial assets. Most forwards on other precious metals and commodities can be regarded as fixed price contracts for goods, because such forwards are not standardized so that the market risks therein can be traded in financial markets in its own weight.

Second, most forwards on gold are aimed for financial investment (including arbitrage), while most forwards on other precious metals and commodities are directly linked to procurement of those materials. Investment in other precious metals and commodities are performed in future markets, rather than OTC forward markets, with some exceptions (e.g., forwards on other precious metals in London Metal Exchange). As a result, the price of gold is affected by macro-economic circumstances, whereas prices of other precious metals are primarily affected by demand in industries.

Third, gold itself has characteristics of financial assets. For example, gold has been used as means to store value due to its fungibility and high liquidity in its market.

[Mrt: For "Silverities" an important doc.]

5. Conclusion
We recommend that a new item of financial gold be clearly established in the financial account. The definition of financial gold should be gold deposited with financial corporations, such as metal accounts London, without physical shipment (especially across borders). Such category broadly corresponds to gold used for investment/speculation by financial corporations and trading firms.If financial gold is newly created, it will be possible to record forward transactions of gold not under services (or goods) but under financial accounts.